Dynamic Scoring and Tax Reform

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2 What We ll Cover: Dynamic Scoring and Tax Reform 1. Tax cuts don t pay for themselves 2. Smart tax reform can generate $300-$400 billion of dynamic growth 3. Debt-financed tax cuts have smaller growth effects 4. Models with most generous estimates don t account for the economic cost of debt 2

3 Tax Cuts Don t Pay For Themselves 3

4 4 Tax Cuts Can t Generate Enough Growth to Self-Finance To self-finance: $1 tax cut would need to produce $6 of growth Reasonable estimates range from -$0.10 to +$1.25 Even Tax Foundation maxes out at $2.35 Source: CRFB calculations and Congressional Budget Office. GDP = Gross Domestic Product

5 Cyclically-Adjusted Revenue After the 1981 & 2001/03 Tax Cuts Percent of Potential Gross Domestic Product 21% Tax Cuts Enacted 19.8% 19% 17% 19.3% % 16.9% 17.8% 15% % 13% Year Source: Congressional Budget Office 5

6 Billions $3,000 Changes in Revenue from CBO s 2001 Baseline $2,700 Projected Revenue After Tax Cuts $2,400 January 2001 Revenue Baseline $2,100 $1,800 Actual Revenue $1, Source: Congressional Budget Office 6

7 Smart Reforms Can Generate $300-$400 Billion of Dynamic Revenue 7

8 Ranges of Dynamic Revenue Feedback $800B Billions of Dollars $700 $600B $520 $400B $200B $0B -$200B $375 $50 $430 $340 $390 $260 $10 $109 (TPC) -$183 $64 (PWBM) <$1 (TPC) $32 -$400B -$600B Camp Tax Plan 2014 Aggressive Rev. Neutral Across the Board Cut -$474 (PWBM) Trump April 2017 House GOP Better Way Source: CBO, JCT, Staff of JCT, Tax Policy Center (TPC), Penn Wharton Budget Model (PWBM), CRFB calculations. 8

9 Wide Range in Potential Dynamic Estimates Dynamic Estimate of Revenue Loss from 10% Tax Rate Cut (Trillions over 10 years) Source: 2005 CBO 9

10 Estimated Dynamic Feedback from Unified Framework $300 Billions in Dynamic Feedback over Ten Years $250 $229b $200 $197b $203b $150 $100 $71b $50 $0 -$50 -$100 Tax Policy Center (available details) -$57b Wharton Model (available details) Wharton (Option A) Wharton (Option B) Wharton (Option C) Source: Tax Policy Center, Penn Wharton Budget Model Note: This is dynamic feedback inclusive of interest only. The framework produces roughly $2.2 to $2.6 trillion in static revenue loss 10

11 Debt-Financed Tax Cuts Generate Less Growth 11

12 12 Debt-Financing Hurts Long-Term Growth While lower tax rates promote work and investment, higher debt discourages investment and by reducing wages eventually discourages work. CBO estimates that every $1 debt crowds out 33 cents of investment, leading to slower growth. Debt-financed tax cuts also drive up interest rates, increasing interest payments and offsetting revenue feedback

13 Debt-Financing Hurts Long-Term Growth 13

14 Paid For Tax Reform Is Better for Growth Percent increase in long-run GDP Source: JCT projections of generic tax reform generating $0 and $600 billion of net revenue. 14

15 Generous Feedback Estimates Often Ignore the Economic Cost of Debt 15

16 16 Two Types of Models, One YUGE Difference The long-term impact of tax reform is generally modelled using a Macroeconomic Equilibrium Growth (MEG) or an Overlapping Generations Lifecycle Model (OLG) Both models estimate impact of taxes on decisions of if and how to work and invest, but only OLG assumes foresight To assume foresight, the OLG model assumes future policymakers will finance tax cuts and stabilize the debt through future spending cuts, tax increases or both According to JCT, the OLG average tax rates are higher and transfer payments are lower than they actually are OLG models therefore estimate faster growth by assuming tax cuts will be paid for in the future

17 Generous Growth Estimates Assume Future Offsets $800 $700 $600 $500 $400 Estimates of the Tax Reform Act of 2014 Overlapping Generations (OLG) model Macroeconomic Equilibrium Growth (MEG) model Fed responds to rising income Fed does not respond Assumes Future Offsets $650 $700 $300 $200 $100 $100 $225 $50 $200 $150 $275 $0 Greater change in employment Source: JCT, CRFB calculations Less change in employment Greater change in employment, multinationals shift profits to avoid tax increase Intellectual Property shifts normally Intellectual Property does not shift more than capital 17

18 Generous Growth Estimates Assume Future Offsets 18

19 19 Some Outside Models Also Ignore Debt Impact Tax Foundation Assumes unlimited supply of savings, resulting in no economic impact from even large amounts of debt Also ignores spending feedback, some possible Fed effects GGM-Kotlikoff: Assumes debt-to-gdp stabilizes through efficient taxation inconstant with the current (or reformed) code CEA: Estimate benefit of rate reduction without negative impact of financing (from debt or base broadening)

20 If Dynamic Growth Won t Pay For Tax Cuts, What Are The Options To Do It 20

21 Business Taxes 21

22 Individual Taxes 22